Those now running comparison insurance shopping websites believe that they could be helped if Google enters into the business because the giant search engine could draw more attention to buying insurance online. However, they also believe Google...

Editor's Note: Any reference to TheStreet Ratings and its underlying recommendation does not reflect the opinion of TheStreet, Inc. or any of its contributors including Jim Cramer or Stephanie Link. TheStreet Ratings quantitative algorithm...

Overstock.com Inc. said Friday it is planning to offer its employees the option of being paid in Bitcoin, as par of an effort to encourage broader use of digital currencies. The discount online retailer made the announcement in a release about a...

Related Articles

Overstock.com (NYSE:OSTK) is an online marketplace that offers discounted brand name merchandise purchased from the surplus inventories of manufacturers and retailers. Although its been able to cut costs effectively since its inception in 1997, the company has incurred yearly net losses due to high operating expenses[1].

At the heart of Overstock's challenges is the increasing competition to attract customers. It operates in a very competitive market and as search engines such as Google have become more popular, customers begin their search for online merchandise through general search rather than through the established platforms of Overstock or competitors Amazon and Ebay. As a result, Overstock must spend large sums on acquiring search engine promotion. Additionally, poor global economic conditions have affected consumer demand for the kind of goods that Overstock sells.

The only way to overcome the search engine filtering by customers is to build a strong brand so that when people look for value (jewelry, fixtures, or travel, or insurance) they know that Overstock.com provides it and start their search from there (like with Google for search or Amazon for books). Overstock seems aware of that and spends money in targetted online advertising but also in brand advertising (TV, radio, print and most recently the Oakland Coliseum).

Overstock managed to build critical mass (web-estate, trade relations, $1b revenue mark, technology) and achieves about 2.2 million quarterly orders @ $118/order (averages for the last 12 quarters ending Sep-2011). In terms of capital spending 5y average capex < 5y average depreciation which is a positive sign. As of September 30, 2011 the company has federal net operating loss carry forwards of approximately $190.5 million and state net operating loss carry forwards of approximately $174.3 million, which may be used to offset future taxable income. The partnerships concluded towards the end of 2011/early 2010 (nook, travel) are still in test drive but indicate a new growth direction through which Overstock may employ its web estate and customer base with little or no need for additional investment (sales agent for partners like Barnes & Nobles and Priceline).

Some shy profits peeked out in 2009 and 2010. The fact that it benefits of backing of top quality, long term, value oriented shareholders (Byrne family, Fairfax, Chou Funds) provides the company with a competitive advantage.

To be successful, an online agent such as Overstock must be a low cost operator, own a strong brand, attract traffic, offer a likable product portfolio and shelf space, good prices and superior customer service. Amazon is an example of success in the online retailing industry. The company is a far cry from Amazon's numbers but better positioned as compared with many of its competitors.

However, Overstock must prove it is able to grow profitably given that the online shopping space in some of its targeted segments is dominated by the huge brand equity built by Amazon, Ebay (arguably, a competitor) and many of its other competitors' online businesses are backed by helpful brick and mortar networks.

Company Overview

Description

Overstock is an online retailer offering discount brand name, non-brand name and closeout merchandise, including bed-and-bath goods, home décor, kitchenware, furniture, watches and jewelry, apparel, electronics and computers, sporting goods, and designer accessories, among other products. The web site operates four tabs: Shopping, Cars, Insurance, B2B ( www.overstock.com, www.o.co and O.biz). Under the Shopping tab/Worldstock the buyer can procure merchandise from craftsmen in many world's countries. For the time being about 99% of the revenue is generated in the USA but the company could deliver many products to a great deal of international destinations. The company tried various models such as operating various website tabs, operating more US warehouses and local presence in Mexico. One of its promotion initiatives was penalized by Google in 2011 so it was given up (but that might have costed 5% in lost revenue). In the past its systems failed to invoice properly some of the costs which should have been born by Overstocks' fulfillment partners so the company chose, in the end, to bear some of them itself. A more detailed analysis of the company (bull view) is available here. Bearish comments to this bull stance are presented here.

Business Segments

Overstock’s shopping business has two different business lines: Direct Segment and Fulfillment Partner Segment.

Fulfillment Partner Business (80.8% of net sales)

The Fulfillment Partners segment does not ship excess inventory from its leased warehouses; instead, it acts as a liaison between consumers in search of the low prices and retailers, cataloguers, and manufacturers looking to liquidate surplus inventory. Such products are listed on the Overstock.com website and then shipped by the third party "fulfillment partners". Overstock has roughly 1,900 partnerships with third parties who post approximately 960,000 SKU's products on the Overstock.com website. Revenue generated from sales on the Shopping site from both the direct and fulfillment partner businesses is recorded net of returns, coupons and other discounts.

This segment, as well as the Direct segment, are highly seasonal, with sales historically peaking in its fourth fiscal quarter. Overstock also controls a number of peripheral business lines that are based on the same concept of using the Internet to facilitate consumer access to discount merchandise. These including auctions, auto sale listings, and real estate sale listings, all of which contribute negligibly to the company’s revenue.

Direct Segment (18.2% of net sales)

Direct revenue includes sales directly to individual consumers from certain offline channels and Overstock.com's leased warehouses, where purchased surplus inventory is stored and then re-sold at a premium on the website.

Management Compensation

The Proxy Statement as well as the transcript of the 2011 Stockholders’ Meeting provides more detail but a few excerpts make the point:

1) After ten years of service without any salary or bonus, Patrick Byrne, agreed to accept a salary of $100,000 for 2011; 2) The other Executive Officers’ salaries stay at the same rates paid in 2010, as follows: Mr. Johnson: $350,000; Mr. Chesnut: $300,000; Ms. Simon: $300,000; and Mr. Peterson: $300,000; 3) the Compensation Committee approved the recommendation of the Executive Officers that they be paid no bonuses relating to 2010 (according to the transcript of 2011 Shareholders’ Meeting they gave up their bonuses so that the employees could have theirs); 4) The number of restricted stock units granted to Executive Officers were as follow: Dr. Byrne: 15,000; Mr. Johnson: 15,000; Mr. Chesnut: 15,000; Ms. Simon: 15,000; and Mr. Peterson: 15,000; 5) Substantially all employees of the Company are expected to be eligible to participate in any bonuses ultimately paid under the 2011 Bonus Plan. The total bonus pool under the 2011 Bonus Plan is expected to be an amount equal to 20% of post-bonus ‘‘Measurement Amount’’, with 20% of the pool expected to be allocated to the members of the executive team (18 people).

The fact that 80% of the bonus pool is reserved for employees suggest a certain management attitude towards them which in turn might explain the 9th place occupied by Overstock in Glasdoor's Employees' Choice Awards for Best Places to Work.

In 2007, Overstock filed an unfair business practice lawsuit against some prime brokers over the practice of naked short selling. “I didn’t want to fight this fight. ... I'm telling you there is a crack in the financial system. It's filling up with phantom shares until they so warp the market ...” declared Mr. Patrick Byrne, on a conference call (Q1-2006, page 3). An article (FalseProxies) from Bloomberg Markets explains some elements of the “crack” that made Patrick pick that fight.

The Prime Broker Lawsuit (trial date set in March 2012) with Goldman Sachs and Merrill Lynch/BAC as the remaining defendants (some other prime brokers have settled, see OSTK 10-K, 2010, page 33). This trial, David vs. Goliath type of story, might raise a lot of public interest – and a great deal of goodwill and name recognition for Overstock.com.

Originally, Overstock has asked for $3.48 billion in damages from the prime brokers.

Information on Overstock's and other comparable "Phantom Shares" legal proceedings is available here. More specific information on Overstock's litigation is presented here.

Other Litigation

The company faces some headwinds from district attorneys in California who filed a suit in 2010 and claim that Overstock made "misleading statements ". The Consumer Affairs.com provides more details. An excerpt is below:

"Overstock made "misleading statements "which accompanied virtually every product listing on its site," according to the suit. By way of example, the complaint points to a patio set that Overstock claimed had a "list price" of $999. The website offered the set for a seemingly rock-bottom $449. But a consumer who bought the set on Overstock found a Wal-Mart sticker listing the sale price as $247 -- a full $200 cheaper than the price at which Overstock offered the set. Mark Griffin, Overstock's vice president and general counsel, said in a statement that "no one is perfect but also that Overstock "[does] deny the allegations and we deny the interpretations." Griffin said that misrepresenting prices would be devastating for a company that has plenty of competition. "The bottom line is that people shop our website in large part because of the prices we offer," he said. "So we have to be as accurate as possible because we know that our customers can easily check the prices that are available elsewhere." As for the patio set, Griffin said it was a misunderstanding between Overstock and its vendor."

This suit is in the discovery stage and Overstock intends "to vigorously defend this action". The latest [1] provides more information about the outstanding litigation.

Business Growth

Trends and Forces

According to Internet Retailer's Top500, Overstock is no 27 in the list of Top 500 business-to-consumers retailers in the US and Canada, based on on-line sales 2010. In terms of 2010 sales growth, Overstock outpaced 39 of the top 55 retailers (website with chart) ranked by Internet Retailer's Top 500.

Competition for Customers

Customer acquisition and retention has become increasingly difficult for specialized internet retailers such as Overstock. Customers have an ever greater choice of websites from which to search for merchandise for retail purchase. Over the last several years, Overstock has been competing for traffic and spent large sums on marketing.

According to Alexa, on Dec 18, 2011, Overstock's global rank is 558 and its US rank is 99 (among all sites in Alexa's universe). See the chart at this link: Traffic (were you can dig for more for information) or below:

The fall in the first part of 2011 coincides with the rather sudden replacement of www.overstock.com for www.o.co, a mistake acknowledged and repaired by management as the graph's subsequent evolution points out.

This link provides Alexa's rank of shopping sites. Overstock takes the 16th place which suggests Overstock's web estate is valuable and a platform to build on which might not be so easily achieved by competitors.

The fact that Overstock is ranked 2nd in retail customer services nationwide, may help in making a difference [2]

Overstock has begun to focus on attracting international customers and has service to 90 international customers. Overstock is using FiftyOne Global Ecommerce solutions to facillitate its international presence.[3]

All that being said, according to the company's presentations, a number of operational improvements are visible. A slightly increasing pool of customers (the sudden re-branding and the Google penalty took a toll on Q2, Q3-2011) places a slightly increasing number of orders at a slightly increasing average order value:

The Net Promoter Scores (% of promoters - % of detractors) provided in the company's presentations show improving customer service.

Taxes against Online Retailers

In May 2008, New York state passed a law requiring Internet retailers to collect and pay New York state taxes. Previously, online retailers have only had to collect sales taxes from online shoppers in states which they have a physical presence. Thus, Utah-based Overstock would only have to collect taxes from Utah customers. However, New York enacted a law that treats affiliates of online stores as extensions of the store itself. Because Overstock has over 3,400 affiliates in New York, it would have to collect sales tax on its customers in New York. Rather than collecting sales tax, Overstock cut all its New York affiliates, removing their "physical presence" from the state.[4]

In February 2010, the California State Senate passed a bill requiring online retailers to start charging sales tax on purchases in California. The new tax, nicknamed the "Amazon tax", was included in a $5 billion state budget package and was estimated to contribute $107 million annually to California's budget. However, Gov. Arnold Schwarzenegger said he would veto the the bill.[5]

As more and more states try to collect sales taxes from online retailers, these new taxes will cut into Overstock's revenue. When the price of a product is raised due to the new taxes, consumers will buy less quantity, eroding Overstock and other online retailer's revenue.

Internet Purchasing

Many factors can influence a consumer’s decision whether to buy online or in-store. One of the most prominent advantages of purchasing goods on the internet was the lack of sales taxes. However, to combat soaring budget deficits, states such as North Carolina and Rhode Island are now requiring sales tax to be paid on goods sold on the internet[6]. This makes internet shopping much less attractive to those buyers trying to find a bargain from internet sites such as Overstock, and the company has had to cut ties with 3,400 online affiliates in 2009 in response to tax changes.

The entire on-line retailing industry faces headwinds due to the local states tax issue whose resolution is not predictable. It is unlikely to see the industry or Overstock destroyed by this tax but it might make days cloudier for all of the players, especially the weaker ones - which in the end may benefit the stronger ones.

Other factors which play a role in willingness to purchase online are secure credit card payments and broadband internet access. As buying online becomes more secure with the likes of PayPal and the rates of broadband internet penetration rise, consumers should be more likely to purchase from the web.

Downloadable Media

The use of downloadable media programs such as iTunes, Kazaa, Morpheus, Bittorrent, and Napster has had a negative impact on the CD/DVD industry. As these downloading systems become more established, hard copies of music and movies have become increasingly obsolete. Considering digital media has historically contributed greatly to Overstock's revenue, this could have a negative impact on Overstock's top line.

Competition

The industry has minimal and low cost barriers to entry and therefore it is a very competitive market. Overstock has many competitors in the Internet sales business, including Ebay, Amazon, Buy.com, Shop.com, and Smartbargains.com.

Easy entry (technically) does not necessarily mean that a new entrant can build easily web estate, traffic, customer base, etc. One must consider that Overstock's business model consists of two distinct business lines: a) selling the overstock of others; b) helping others sell their merchandise (travel, books, insurance, etc). Trade relationships (+1900 supplier base), customer relationships (more than 22 million customers), technology and web estate are not that easy to build for a new entrant in the current market environment. An online business model is better positioned to succeed if it employs: a) brand/traffic; b) heaviest discounter reputation (which is probably part of the brand equity); c) low cost operations.

Is Overstock a great brand yet?

It is difficult to know how Overstock divides its marketing budget between different lines (Sales and Marketing expenses consist primarily of online and offline advertising, public relations and promotional expenditures, as well as payroll and related expenses for personnel engaged in marketing and selling activities) but they do spend money on marketing at the expense of net profits:

"O.co also known as Overstock.com"

Spending USD 363 million on sales and marketing (a chunk of each is marketing alone) during the last six years clearly shows the Overstock's management is aware of the importance of brand. Yet, interestingly, they chose to suddenly replace Overstock.com with O.co in February 2011 (!...). The cold shower which followed sent a strong message and now they try to work it out properly (O.co is catchy but Overstock stands for something).

The closer proxy for brand value may be Internet Retailer's Top500 and Alexa rankings which position Overstock as no 27 or no 16 online shopper in the US.

Is Overstock the heaviest discounter of them all?

A look in the table below, which outlines COGS as a % of revenues for some players, provides a rough general picture:

Overstock's COGS as a % of net sales, shows that they are either a heavy discounter or they do not control the purse strings when buying merchandise. The former might be closer to the truth and in 2012 COGS is ~83% of sales as compared to 85% the average of previous 9 years. That shows an improvement. Hard to say based on public data if it is due to: a) increased bargaining power with suppliers?; b) closure of warehouse in Indiana (2007)? c) increased fulfillment partner weight in total revenues? d) higher sales prices?

Is Overstock a low cost operator?

The adjusted SG&A presented in the table below consists of the sum of the SG &A and R&D percentages, as provided by Morningstar for each player. Again the analysis is rough but it glimpses at the competitive landscape:

In terms of SG & A Overstock looks worse than some competitors, and better than others. The trend is positive (with ups and downs but decreasing).

Industry Position

Overstock is a far cry from Amazon but it employs a bundle of assets that position the company better than many of its competitors:

web estate

critical mass

sustainable capex

supportive, resources-full, long term controlling shareholders

focus on expense control and web technology improvement

value oriented management & private company management style

Will these assets be managed properly for domestic growth and profits? Can Overstock become a global player?

The next five years shall prove the evolution of its business model and the happiness of its public shareholders one way or another.